Control Spending
True stories can be very instructive, so we are providing one from our own
experience. Sadly, it is not unique. In fact, the couple we write
about is a composite of several clients who have been trapped by debt. And for that reason we provide
the six step solution at the end of the story.
The Story
Up to two years ago, we had a couple as clients (let's
call them Jack and Jill) who were "living life large". They had just
bought a large new house in the "burbs", and two new cars. Both Jack and Jill had good
jobs with the commensurate salaries. Jack is a project manager for a large
government contractor.
Jill is a professional woman. All seemed picture perfect, except, it was
the picture of a house built of cards -- credit cards. When
our financial counselor last met with them on an annual review, what he found
was troubling. Only a few years earlier the couple had been nearly debt free.
Now the couple had four credit cards, all of which were at or near their limits,
and an "interest only" mortgage on the new home.
Early on, at their initial meeting, our financial
counselor convinced Jack and Jill that debt reduction should be a primary
financial objective in their financial plan. While they were disciplined
investors who had accumulated a modest portfolio of mutual funds, their spending
was out of control. Jack and Jill agreed to pay off the credit card debt with money from the sale
their mutual
funds. Unfortunately, just a few years later, the credit card debt was
back. How did this happen?
This debt problem started with school and car loans,
but was compounded by Jill's
habit of shopping to make herself feel better. She would go to the mall
and buy knick knacks or other items for the house. Soon the "things and
stuff" out grew their home.
And then with the birth of their child, it was time to sell their
first home and move up.
So Jack and Jill bought a big brand new
house with more rooms than their old home. This meant a lot of empty space
to fill up with "things and stuff". So naturally, they charged new
furniture on credit cards. Jack was not worried about it -- he had the
solution.
Jack got caught up in the euphoria of the ever
increasing appreciation of homes in their geographic area. This assumption
became the basis for all his financial planning regarding their debt problem.
According to this thinking, all one had to do was refinance every few years and
take the cash out of the equity in the home to pay off the credit cards.
Our counselor realized Jack's assumption was "pie in the sky".
One can not expect the current performance of any
asset class (including the value of homes), to continue into the future. Sometime in the future there
will be a change, either up or down.
What is such a disappointment for our counselor is, the
debt problem had been corrected, not once but twice in the past. At one point, (when they had equity in their old house) Jack
and Jill used a home equity to pay off their high interest credit cards.
But
contrary to the advice he had given them, they did not destroy their cards. So
here they were again, with credit card debt back with a vengeance but this
time, unknown to them, with a future of housing value depreciation. What a
financially toxic combination! Yes, "Jack (did) fall
down and broke his crown and Jill came tumbling after." A very sad but
true story, not just a nursery rhyme. So how do you fix this situation?
The Real Solution
1. Face the Problem
Don't be in denial. If you pay off credit cards and then find a year or
so later you still have high credit card debt -- something's wrong.
Instead of trying to place blame on someone else or some situation, look in the
mirror and ask that person how s/he is going to change their behavior.
2. Kill the Beast
First the credit cards themselves; cut them up, melt
them down, chop them up, shred them. Do whatever gives
you a sense of a dramatic milestone in your life. The day you destroyed
the beast! This will not
automatically change your spending behavior, but is a start. You are
taking decisive action. However the next action is harder.
The fundamental problem is how you
think of money. One's relationship with money may be something learned from your
parents and may be deep seeded in your psyche. Or it just may be you are
caught up in our consumer culture. While there are hoards of "non
profit" credit
counseling companies willing to take your money, perhaps it may be more appropriate to go to a
therapist. After all we are talking about changing behavior.
From the "men in white coats", to the money in white envelopes.
It is the white envelope cash system. Begin by labeling each envelop with the need or bill for
which the money is to be used. Then put cash or a check in it to pay for the need
or bill. For example, $100.00 a week for food. Once the cash is
spent; that's it. If you need more food, you will need to pull the cash
from another white envelop, maybe the one labeled "recreation". The point
being, you pay for everything with cash -- no credit card use.
3. The Pay Off
Once you've put a brake on going further into debt, start making a dent in
the amount you already owe. You're far more likely to make steady progress if
you have a specific game plan to follow, rather than relying on willpower.
The best strategy, if there's a wide spread in the
interest rates on your debts is to pay off your highest-rate debt first.
Make the maximum monthly payment you can afford on that card , while you pay the
minimum required on the rest. As the interest buildup on that card goes
down, you start to pay down the principal faster. Repeat the process with the
next highest rate card and so on. If the range of rates among your loans isn't
big, pay off your smallest debt instead. The results feel more meaningful, and
you'll get a psychological boost from paying off a card completely. "It
encourages good behavior," says financial planner Scott Cole in Birmingham, AL.
4. Watch Out for Paying off Debt with Debt:
You know the game -- roll the old high interest credit card with a new credit
card offering lower interest rate. And then there is the classic play of,
"I'll use my home equity loan to pay my credit card debt off". What
happens when you do that and then you need to replace your roof a year or so later?
5. Get Help:
Start with help from the best and the highest source available to you.
This is where the "Finance and Faith Link" comes in.
Click here for
WHAT WE BELIEVE. As far as credit counselors go, be careful.
Watch out for up-front
charges of higher than $75.00 To find a legitimate agency,
contact the Association of Independent Consumer Credit Counseling Agencies (aicca.org)
or the National Foundation for Credit Counseling (www.nfcc.org).
6. "Don't Stop Thinking about Tomorrow":
Finally, as bad as your debt may be, don't use it as an excuse to ignore the
rest of your financial life. Set a little money aside for an emergency fund so
the next time life knocks you for a loop, you won't start borrowing again to
recover. And then there is your retirement, put a token, maybe $25 per paycheck into your 401(k) to get in the habit of
saving.
(Some of the information on the above steps is an adaptation of material in the article:
"Being Grown Up About
Debt", by George Mannes. It appeared in Money magazine, Feb., 2007.)
